A Markov regime switching model of crises and contagion: the case of the Iberian countries in the EMS

Jose Mario Lopes, Luís Catela Nunes

Research output: Contribution to journalArticlepeer-review

5 Citations (Scopus)

Abstract

We develop a general econometric model of currency crises and contagion that integrates a number of important features appearing in many different models recently proposed in the literature. In particular, we consider a Markov regime switching vector autoregression conditional heteroskedastic model with time-varying transition probabilities allowing for shifting correlations. This model is used to study the case of the Portuguese escudo and the Spanish peseta during the EMS crisis. The results show that, in a crisis situation, the interest rate differential has different effects on the transition probability from the crisis state to the non-crisis state: a perverse effect for Portugal, and a positive effect for Spain. We also find strong evidence of contagion, mostly from the Spanish peseta to the Portuguese escudo, and to some extent from the Portuguese escudo to the Spanish peseta.
Original languageEnglish
Pages (from-to)1141-1153
JournalJournal of Macroeconomics
Volume34
Issue number4
DOIs
Publication statusPublished - Dec 2012

Keywords

  • Currency crisis
  • Contagion
  • Markov switching

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